Jim Leaviss: Navigating the inflation conundrum
Managing rising costs amid myriad macro risks
The next year or so will see significant disinflation around the world.
While there are clearly some inflationary forces in the economy at the moment, these will be by far overtaken by the huge fall in demand and energy prices which we have seen over the last few months.
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Oil prices actually turned negative in March, so we shouldn't be surprised to see very low inflation numbers, at least until we all come out of lockdown.
Looking into 2021, a rebound in inflationary forces is likely, most importantly simply due to the so-called "base effect" of low oil prices.
The ultra-low oil prices we saw earlier this year make an increase in 2021's year-on-year inflation rates almost mathematically certain, assuming oil prices do not return to minus $30 per barrel.
Add to this the unprecedented level of government spending, the central bank interest rate cuts, cheap loans for businesses, and more quantitative easing (which some equate to money printing) and inflationary pressures could return to the global economy, especially in the event of a 'V-shaped' recovery having been more or less absent since the 1980s.
Even bigger inflationary forces may be at play too. For example, the current tensions between the US and China raise the question of whether the globalisation of the past few decades (which has been disinflationary) will slow or even reverse.
We are used to cheap goods flowing into the developed world from Asia - will nations decide that they want to be more self-sufficient in goods and food in future? Might new tariffs make imports more expensive and raise the cost of living?
While most of us expect the global economy to rebound sharply once we are past the immediate threat from coronavirus, it is possible that some long-term damage has been done.
Will all companies hire back as many workers as they have made redundant this year? Might consumers and businesses be frightened of spending and investing in an uncertain world? And could the reversal of the globalisation trend reduce overall global growth in a significant way?
The worst of all worlds would be a scenario where the co-ordinated stimulus results in inflation, but where growth and economic activity is very weak. For those that remember the 1970s, this toxic combination is known as "stagflation".
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Despite all this, there are a number of strong forces still in the market which have helped maintain a multi-decade downtrend of lower inflation. In light of these conflicting inflationary/deflationary forces, inflation-protected bonds, particularly US TIPS, offer some cheap insurance at the moment in case inflation does pick up meaningfully.
There is less potential downside to owning these over core nominal rates even if inflation doesn't come through very strongly over the next few years, so they offer good insurance given the current uncertainty.
Jim Leaviss is CIO of public fixed income at M&G
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